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Monday, November 8, 2010

Leverage Misuse and Abuse in FOREX

Forex is the worldwide currency exchange market, also known as the foreign exchange market, "fx" for short. This is an over-the-counter electronic trading market for the major worldwide currencies. It offers easy entry to the average public trader and fairly low margin requirements.

However, this low margin and high leverage is also the #1 risk and cause of loss among novice Forex traders. Misuse of leverage is the Forex cardinal sin. In the article below I'm going to explain the new leverage rules, and show you exactly how to take advantage of it! To give you even more I put together this Free Forex Toolkit with an entire video section dedicated to using the new leverage rules to consistently profit…GET IT HERE.

What do we mean by low margin and what is leverage? Well basically this means that you can control a huge amount of a currency in the Forex market with a very small cash outlay. The normal stock and index options that we trade at BigTrends.com represent 100 shares of stock — you pay a premium to control/own this option. For example, in the stock option market you may be able to control the right to buy 100 shares of IBM for $500 — this is an example of leverage. However, the leverage in Forex is much greater than this in most cases … but so is the risk.

We only have to look at the recent housing market crash to see an example of where leverage and low margin caused massive losses among individual investors. People across the world were buying houses and properties beyond their means and with very little cash down. Many of these were speculative, greedy bets on a continued sharp rise in housing prices — which knowledgeable, experienced traders such as ourselves knew wouldn't continue forever. They weren't bad homeowners; they simply misused leverage.

The huge amount of potential leverage and low margin requirements in fx trading is similar to this. The latest rules allow Forex leverage for 50:1 on major currencies and 20:1 on minor currencies. Some brokers may still be able to offer 100:1 leverage. What this means is that a trader can often control millions of dollars of a currency proposition with a very small cash outlay. When novice traders allow emotions such as greed and fear to rule their trading, they often end up on the losing end of large leveraged bets.

Thanks for reading, and we've got a lot more where that came from! While you wait for our next article get our Free Forex Toolkit that will put your Forex trading on the right track!

Author Scott Downing is the Director of Research at BigTrends.com. Having learned to trade options under Price Headley, Scott was eager to make his mark on the trading world by applying his systematic approach to other asset classes. He was immediately drawn to FOREX due to the liquidity, leverage and lucrative nature of that market. From there, Scott set out to help other traders overcome their individual challenges to achieve successful FOREX trading.